Smart metering: two cautionary tales

Meter markets now include smart metering technology, opening up a growing area of differentiation and competitive conduct between energy firms, which can involve competition law issues, says Gary Hughes of Chapman Tripp.

The growth of the smart metering industry has seen new areas of differentiation and competitive conduct emerge. Competition law implications can arise, as two recent developments show, in New Zealand and in the UK.

The New Zealand High Court has dismissed the Commerce Commission’s case against Bay of Plenty Electricity Limited (BOPE), which alleged that refusing to lease electricity meters to competitors breached the Commerce Act.

Two months later, the UK energy market regulator (OFGEM) fined the gas transmission/distribution company National Grid £41.6 million for imposing anti-competitive conditions in long-term contracts in the British gas metering market.

In the BOPE case, the behaviour that upset the Commerce Commission was a refusal to allow its existing meters and ripple relays on customers’ premises to be leased by rival electricity retailers who wanted to supply those customers.

This behaviour dated back to 1999, when BOPE was formed by the Electricity Industry Reform Act’s split of the Bay of Plenty retail supply business from its lines business.

In the aftermath of that market restructuring, many retail companies sprang up attempting to win customers in regions outside their former incumbent areas. A chaotic period followed, as customer marketing initiatives outran the ability of firms (and the MARIA protocols then in place) to ensure smooth switching of customers.

In its incumbent area BOPE took the view (contrary to what was happening elsewhere in New Zealand), that it was not interested in leasing its meters to other retailers. BOPE was prepared, at various stages, to sell or swap the meters, or propose other options for rivals such as installing new meters of their own or leasing from a third party.

The Commission argued that refusing to lease existing meters left rivals with a series of unpalatable options that were not economically feasible, given the low returns on domestic meter charges, and the heightened risk of asset-stranding. The refusal therefore prevented or deterred potential competitors from supplying electricity or contesting the market for BOPE’s customers.

In legal terms the competition effects were characterised as:

refusing to allow access to a facility, or to supply an important service, needed to compete with BOPE to supply electricity; or

raising the costs of rival suppliers, forcing them into a more costly exercise of buying or installing meters in order to supply electricity.

Proving a breach of section 36 of the Commerce Act is just about the hardest task facing the Commission, and so it proved on this occasion. Section 36 prevents a firm taking advantage of market power for anti-competitive purposes (a purpose of restricting entry to a market, preventing or deterring competitive conduct, or eliminating a rival).

The court agreed with the heart of BOPE’s position: that it was not obliged (whether it had market power or not) to necessarily provide rivals with the cheapest or easiest way into its markets. This is orthodox stuff in competition law terms: even a dominant firm is not obliged to "help" competitors enter via the least-cost route. It can refuse to supply when alternatives exist, even if they require more up-front investment.

The case had some unusual features. For instance, BOPE is a minnow amongst electricity retailers. As incumbent, it did control most meters in its local region, but the firms complaining about the cost of trying to enter the market included much larger SOEs and retail players. Part of BOPE’s problem was that its behaviour looked decidedly out of kilter with the rest of the country, where most retailers were content to allow leasing of existing meters and facilitate customer switching with a minimum of fuss.

Even so, whether other competitors chose to reciprocate generously in their own regions was irrelevant to the legal issue. The court decided that BOPE’s conduct did not breach section 36.

Interestingly, the Court did frown upon other allegations that BOPE had engaged in delaying tactics and exaggerated to consumers the inconvenience and switching costs of changing meters to a new supplier. These tactics could have amounted to obstructing customers from switching to other retailers, and suggested an anti-competitive "purpose", but the way the Commission ran its case was not based on those ancillary activities, and a breach was not proven. The Commission has appealed the decision, but it appears unlikely to be heard before the end of this year.

The UK case

In the UK, OFGEM was unhappy that National Grid (NG) had signed up gas suppliers to long-term exclusive meter supply contracts that prevented them replacing or installing new meters faster than a rate dictated by NG. NG, a descendant of the British Gas empire, controls much of the gas distribution network. Although meter markets had been open to competitive supply for several years, NG still held about 90 percent of Britain’s 22 million domestic gas meters. NG contracts with gas suppliers, who largely manage the customer relationship and have a choice of meter providers. In 2004, NG devised a complicated Metering Services Agreement (MSA) which rebalanced pricing and included: an 18-year contract, with gas suppliers committed to renting a minimum number of NG’s meters; a downward "glidepath" over time for the minimum number; and additional charges or penalties for renting less than the minimum. The MSA effectively set a limit on how many NG meters could be freely replaced (for any reason). If that quota was exceeded by replacing meters faster than agreed, a form of "take or pay" and other "early replacement" penalties began to bite on gas suppliers. To OFGEM, this mechanism prescribed replacement rates as a device to prevent gas suppliers seeking better, cheaper deals from other meter companies. For competitors, it foreclosed them from entering or growing in the meter market. For consumers, it could slow down or discourage gas suppliers from installing new smart meter technology.

NG argued that gas suppliers could stay on their old contract terms (which one of the six major suppliers did), or choose to take lower rental prices by agreeing new terms. The MSA also "bundled" maintenance services into a single charge for rental and maintenance. OFGEM said this exacerbated any foreclosure effect, because a maintenance call out often resulted in the meter being replaced altogether. If NG carried out all maintenance visits, it would replace (where necessary) with NG meters. So even a gas supplier electing to use a competitor (not NG) would still take maintenance services from NG for old legacy stock meters, and faced possible automatic replacement by NG. These contractual features together amounted to abuse of a dominant position in the markets for domestic gas meters and meter maintenance services. OFGEM imposed a £41.6 million fine to mark the serious restriction on market development and smart metering innovation. National Grid remains convinced it has done nothing wrong, and is appealing.

Lessons to be learnt

These two cases illustrate the ways in which competitive urges in meter markets might come under scrutiny by regulators. While New Zealand and English competition laws are different, and the market characteristics are very different, some themes can be seen. The desire to protect incumbency positions in the face of forceful newcomers is a regular competition law problem in utility markets. Secondly, regulators the world over get irked if incumbent-newcomer battles impede innovation or dynamic efficiency, or slow the roll-out of new technology that would benefit consumers. Metering, mundane as it may seem, is in the front line of rivalry for customers. Located right in the customer’s premises, a switch of meter providers carries potential for consumer disruption, billing-system glitches and wasteful duplication or replacement of equipment. Competition authorities will therefore monitor these markets closely.